AN ANALYSIS OF MERGERS IN THE PRIVATE CORPORATE SECTOR IN INDIA

Transcription

1 1 AN ANALYSIS OF MERGERS IN THE PRIVATE CORPORATE SECTOR IN INDIA P.L. Beena Working Paper No. 301 March 2000

2 2

3 3 AN ANALYSIS OF MERGERS IN THE PRIVATE CORPORATE SECTOR IN INDIA P. L. Beena Post Doctoral Fellow* Centre for Development Studies Thiruvananthapuram March 2000 This paper is drawn from my Ph.D thesis [Beena, 1998] completed at Centre for Economics Studies and Planning, Jawaharlal Nehru University, New Delhi. I wish to thank my supervisor Prof. C.P Chandrasekhar for introducing me to this area and providing me with stimulating ideas. I also wish to thank Prof.K.K.Subrahmanian, Mr. J. Dennis Raja Kumar, and Ms. Meena Abraham for the useful discussions I had with them. However, I am alone responsible for the remaining errors. * Was a Post Doctoral Fellow in the Planning Commission Unit in Development Economics at the Centre for Development Studies, Trivandrum from

4 4 ABSTRACT The liberalised economic policies have exposed Indian industry to several challenges. In response to this, the Indian economy has witnessed a sharp increase in mergers and acquisitions. An attempt has been made in this paper to analyse the significance of such mergers and its characteristics. The study suggests that acceleration of the merger movement in the early 1990s is accompanied by the dominance of mergers between firms belonging to same business group or house with similar product lines. So it is argued that though the merger movement in the early 1990s might have contributed to an increase in product or asset concentration measured on a firm-wise basis, it could not have contributed to an increase in concentration as measured by relative shares of business groups. But, there are signs that mergers between unrelated firms, though numerically less significant, have been gaining ground. This is especially true of mergers involving foreign-owned firms. The participation of foreign-controlled firms in the merger process has increased significantly since However it is evident that mergers contributed significantly to asset-growth in only one fifth of the sample firms studied. Most of these firms mobilised a large share of resources through capital markets, to finance their expansion during to Therefore the study argues that the merger wave in the early 1990s was more a means of internal restructuring rather than an instrument to further product market or asset share. JEL Classification : D43, G34, L41 Key Words: mergers and acquisitions; horizontal merger, vertical merger, conglomeration, private corporate sector, India

5 5 Introduction The structural adjustment programme and the new industrial policy adopted by the Government of India would allow business houses to undertake without restriction any programme of expansion either by entering into a new market or through expansion in an existing market. In that context, it also appears that Indian business houses are increasingly resorting to mergers and acquisitions as a means to growth. The present paper seeks to analyse the role of such mergers in the private corporate manufacturing sector during the early 1990s. This paper consists of five sections. The first section discusses the concepts and definitions and some theoretical issues related to mergers. The second section explains the different type of "merger wave" occurred in developed countries and the Indian experience. The third section analyses the significance of merger process in the 1990s. This section also explains the data source and the method used for selecting the samples. An in-depth analysis of the characteristics of these mergers in terms of management and of their economic rationale is carried out in the fourth section. The role of acquisitions in the growth of assets of acquiring firms and sources of financing their growth are analysed in the last section.

6 6 Section I Concepts and Definition Mergers or amalgamation, result in the combination of two or more companies into one, wherein the merging entities lose their identities. No fresh investment is made through this process. However, an exchange of shares takes place between the entities involved in such a process. Generally, the company that survives is the buyer which retains its identity and the seller company is extinguished (Ramaiya, 1977). A merger can also be defined as an amalgamation if all assets and liabilities of one company are transferred to the transferee company in consideration of payment in the form of equity shares of the transferee company or debentures or cash or a mix of the above modes of payment. An acquisition, on the other hand, is aimed at gaining a controlling interest in the share capital of acquired company. It can be enforced through an agreement with the persons holding a majority interest in the company's management or through purchasing shares in the open market or purchasing new shares by private treaty or by making a take-over offer to the general body of shareholders. A takeover, which is essentially an acquisition, differs from a merger in its approach to business combinations. In the process of takeover, the acquiring company decides the maximum price that is to be offered to the acquired firm and hence takes lesser time in completing a transaction than in mergers, provided the top management of the acquired company is co-operative. In merger transactions, the consideration is paid for in shares whereas in a takeover, the consideration is in the form of cash. However, mergers and takeovers can be treated as similar processes, since in both cases at least one set of shareholders looses executive control over a corporation which they otherwise held.

7 7 Based on the objective profile of an offer, business combinations such as mergers, acquisitions or takeovers could be categorised as vertical, horizontal, circular or conglomerate mergers (Peter, 1975). Vertical Combination A vertical combination is one in which a company takes over or seeks a merger with another company in order to ensure backward integration or assimilation of the sources of supply or forward integration towards market outlets. The acquirer company gains a strong position due to the imperfect market of its intermediary products and also through control over product specifications. However, these gains must be weighed against the adverse effects of the merger. For instance, firms which have monopoly power in one stage may increase barriers to entry through vertical integration and this would help to discriminate between different purchasers by monopolisation of raw material supplies or distributive outlets (Comanor, 1967). Horizontal Combination A horizontal combination is a merger of two competing firms belonging to the same industry which are at the same stage of the industrial process. These mergers are carried out to obtain economies of scale in production by eliminating duplication of facilities and operations and broadening the product line, reducing investment in working capital, eliminating competition through product concentration, reducing advertising costs, increasing market segments and exercising better control over the market. It is also an indirect route to achieving technical economies of large scale. Circular Combination In a circular combination, companies producing distinct products in the same industry, seek amalgamation to share common distribution

8 8 and research facilities in order to obtain economies by eliminating costs of duplication and promoting market enlargement. The acquiring company obtains benefits in the form of economies of resource sharing and diversification (Ansoff and Weston, 1962). Conglomerate Combination A conglomerate combination is the amalgamation of two companies engaged in unrelated industries. It enhances the overall stability of the acquirer company and improves the balance in the company's total portfolio of diverse products and production processes. Through this process, the acquired firm gets access to the existing productive resources of the conglomerate which result in technical efficiency and furthermore it can have access to the greater financial strength of the present acquirer which provides a financial basis for further expansion by acquiring potential competitors. These processes also lead to changes in the structure and behaviour of acquired industries since it opens up new possibilities (Mueller, 1969). Mergers, Growth and Diversification Mergers, we have mentioned, are an important means to corporate growth. A firm or a group can be expanded in several ways. One way of growth, is through the extension of existing activities by upscaling capacities or establishing a new firm with fresh investment in existing product markets. However, a firm normally faces two major constraints when it seeks to grow within a single market. When the size of the market is small and the rate of expansion is too low, the growth of a set of firms in the same market might affect adversely the growth of other firms. Thus, it could lead to price wars or takeover bids. This, and other constraints such as control by the government over the expansion of

9 9 firms in particular lines, encourage firms to grow by diversifying into other markets. Through diversification, firms can increase their sales by either creating new markets for the same product or entering new markets by diversifying into new product lines. When the present market does not provide much additional opportunity for growth, diversification as a strategy is vital for a firm if it wants to augment its demand base. In practice, diversification is an important way in which firms grow. A firm is said to diversify if it produces new products including intermediate products that are sufficiently different from the existing product lines (Penrose, 1959). Besides, it also diversifies to take account of the changing opportunity costs of its own resources, which might occur when existing markets become relatively less profitable than opportunities for new investments elsewhere. With a growing and reasonably stable industry, a shift can take place in the manufacturing processes, the product profiles and the demand patterns arising out of technological innovations. To reduce this vulnerability, a firm with excellent apparent growth and stability prospects which becomes vulnerable to sudden changes because its product line has a narrow technological and market base, may need to increase its flexibility by broadening this base to new markets and particularly to new areas of technology. For these reasons, during the 1970s, for example, large firms in India and elsewhere had diversified into new fields, related or unrelated to the existing business (Kumar, 1985,p.105). Growth and diversification can be achieved both internally and externally. Mergers, tender offers and joint ventures are all strategies through which a firm can grow externally. A firm would grow by external expansion when it becomes difficult for a firm to use its resources

10 10 efficiently for further growth. Mergers do not require any cash outlay and therefore can be considered as the only way of diversifying activities for a firm whose financial position is not strong and whose managerial and technical services are highly specific to existing products (Penrose, 1959). Section II Merger Waves in the Developed Countries A series of merger waves has been witnessed in many of the marketoriented economies. There have been three major merger waves in the United States during the periods , , and post-world war II. In the US economy, the first merger wave during 1895 to 1904 was characterised by horizontal mergers, which increased concentration in a number of industries. The second wave, , appeared to have been characterised by a higher incidence of vertical integration and diversified mergers. However, the immediate post-war merger boom was relatively smaller. The difference between these two periods can be described as "mergers for monopoly" and "mergers for oligopoly". Antitrust policies appear to have influenced the third wave significantly, which commenced after World War II. (Scherer, 1979). The diversification and conglomerate types dominated the merger movement during the sixties. During the eighties, the nature of mergers has been characterised by a return to specialisation and an enormous increase in real sizes. The merger waves in the US, in the eighties and beyond are characterised by the strong relatedness between the businesses of the merging firms unlike the conglomerate mergers in the sixties and seventies. In constant dollar terms, the mergers during 1988 increased almost four to six times more than the value of mergers in the early seventies. The value of mergers

11 11 which represented 10 to 15 percent of the investments made in plant and machinery in the seventies, increased to percent levels in the later half of the eighties (Weston, et.al, 1996). The other developed countries such as the UK, Canada, France, Germany and Japan have also witnessed periods of a sharp rise in merger activity, although the US has been the most active mergers market. In the United Kingdom, horizontal mergers were the dominant form between 1954 and 1965 and since then there has been a trend towards diversified merger. The value of assets acquired through diversified merger rose to 33 percent in 1972 from 5 percent in The merger wave since 1980s witnessed divestments on a large scale. In 1992 it was accounted for 31 percent of all acquisitions and mergers. A continuously rising trend in mergers has been noticed in Germany since 1958, with exceptionally high growth rates in the number of mergers during 1969 and Indian Experience Though mergers between large business firms have been negotiated and concluded right through the post-independence period in India, a full list of mergers and amalgamations settled during each year has been published only since For this reason the discussion in this paper of the overall trends in mergers and acquisitions in the private corporate sector in India is restricted to the period to However, the constrained choice of the year as the cut off period, is not wholly inappropriate because a number of significant changes in government policies became operative immediately before or in that year. These changes were heralded, inter alia, through the abolition of the managing agency system, the passage of the MRTP Act 1969, the nationalisation of the banking system in 1969 and the announcement of

12 12 new provisions granting tax relief in the Finance Bill for All these initiatives were aimed at curtailing the power of the big business houses and dealing with the adverse consequences of the absence of price competition among the established business groups. They therefore affected the process of growth through mergers as well. The trends in amalgamations and take-overs during the period to are given in the Table 1. The annual number of amalgamations involving non-mrtp companies for the sub-period to was calculated from the lists provided in the annual issues of the publication "Registration and Liquidation of Joint Stock Companies" prepared by the R&D division of the Department of Company Affairs (DCA). Similarly, the annual number of amalgamations and take-overs involving MRTP companies for the period between to was obtained from the lists provided in various issues of the "Annual Report on the Working and Administration of the MRTP Act, 1969". However, the number of take-overs involving non-mrtp companies during this period could not be computed since the relevant lists are not available. Further, separate lists of amalgamations and takeovers for MRTP and Non-MRTP companies are not available for the period after , since sections 23 and 24 of Chapter III which dealt with amalgamations and take-overs were removed through amendments to the MRTP Act, The number of amalgamations for the period 1 The income tax Act, 1961 contains special provisions for some type of amalgamation and provides for some tax reliefs subject to certain conditions. The tax relief relates to development rebate and development allowance. The finance Act, 1967 extended the sphere of reliefs in tax matters in relation to an amalgamation. Under the Act, as amended, the issue of shares by the transferee company to the shareholders of the amalgamating companies will not by itself give rise to a liability to capital gain tax. The shares in the transferee company will be treated as the same as the shares in the amalgamating companies. It further appears that no part of the value of the shares received by shareholders in exchange under a scheme of amalgamation may be considered as dividend.

13 13 Table 1: Trends of Mergers and Acquisitions During to Mergers Takeovers Year Non-Maf Maf Total Non-Maf Maf Total Avg Avg Avg # Avg Na Na Na Source:- Registration and Liquidation of Joint Stock Companies in India, Various Issues. Report on the working and Administration of the MRTP Act, 1969, Department of Company Affairs, GOI, Various Issues. Na = Not Available. # represents only the number of takeovers for and as the data for the rest of the years has not published. between to was, however, computed from lists available in the various issues of the publication "Registration and Liquidation of Joint Stock Companies". There are a number of aspects of the merger movement revealed by these figures. First, from these lists it is clear that both MRTP and non-mrtp companies have used mergers and take-overs as an important means of growth since the 1970s. Second, there are signs of acceleration in the merger movement in the liberalisation years of the 1990s. The

14 14 total number of amalgamations (computed from a listing of acquiring firms alone) during the period to was 156 (See Table 1). That figure remained at 156 during the next quinquennium ( to ), and then fell to 113 during the period to However, facilitated by changes in the policy environment, the number of mergers rose sharply to 236 during the period to Third, the evidence suggests that the number of amalgamations among non-mrtp companies was always more than in the case of MRTP companies during the period to , although the involvement of MRTP companies in the merger movement was relatively higher in the eighties as compared with the seventies (see Table 2). For instance, the total number of mergers among MRTP companies during the periods to and to was 41 and 43 respectively whereas it was only 27 during the period of to This dominance of MRTP companies is of significance, given the evidence discussed earlier, that the MRTP Act did not excessively constrain mergers. Thus mergers may have been a means adopted by non-mrtp firms to exploit the advantages of size in order to build their competitive strengths, including those vis-à-vis the larger companies belonging to the MRTP groups. Further, as reported in Table 2, it has been found that more than 50 percent of mergers during the 1990s involved acquiring firms in the manufacturing sector whose total assets were below Rs. 100 crore. This numerical preponderance of 'non-mrtp' firms is possible because size matters from the point of view of availing the opportunities provided by the new economic policy. For instance, the norm fixed for promoters' contribution for purposes of eligibility for getting loans from financial institutions was hiked to 25 percent with certain relaxation for large projects and projects promoted by first generation entrepreneurs. Further, the debt equity norm for financial institutions which was tightened to 1.5:1 as against 2:1 earlier could be

15 15 relaxed to 2:1 only for large projects. The interest rates on financial assistance provided by term lending institutions were made flexible with a floor rate of 15 percent per annum, and FIs were also allowed to charge higher interest rates on their loans taking in to account factors such as credit worthiness of the borrowing unit (Company News & Notes, 1993). Fourth, the figures also show that MRTP companies have been increasingly resorting to takeovers since the 1970's, although the number was insignificant. However there was a sharp increase (to 91) in the number of takeovers among the MRTP companies during the period between to whereas it was only 15 during the period between to Once again, one of the reasons for this sharp increase in the number of takeovers in the late eighties as compared to the period before that could be the ethos of liberalisation and changes in the law it generated. Table 2: Composition of Amalgamated Companies during the Period Between to MRTP Non-MRTP Year Non-Maf Maf Total Non-Maf Maf Total Na Na Source: Same as Table 1. Na = Not Applicable since MRTP Act has been removed in 1991.

16 16 Fifth, a categorisation of mergers in terms of manufacturing and non-manufacturing firms showed that the participation of manufacturing firms in the merger movement was always higher than that of the nonmanufacturing firms in the case of both MRTP and non-mrtp companies throughout our study period. However, the participation of non-manufacturing firms in the amalgamation trend increased sharply in the 1990s. Thus, the annual average number of mergers among nonmanufacturing firms for the period of , and stood at 10, 8 and 10 respectively whereas it was 22, 23 and 23 in the case of manufacturing firms. However, the average number of nonmanufacturing firms resorting to mergers during the period had touched 22, which was not far below the 25 recorded in the case of manufacturing firms (see Table 1). One reason for this was the financial liberalisation of the 1990s which not merely increased mergers among financial firms for reasons of competitive capacity-building, but also because of a tendency of firms to merge with dormant or "shell" finance companies to facilitate early listing in the stock market. This possibility of being quoted afforded by mergers with financial firms registered in the market, allowed the private limited companies to exploit the capital market boom through the private placement of shares. A merger with a listed company allowed the firm concerned to provide a guarantee to the external investor that the shares would be listed within a specified period so as to offer the investor the possibility of exit. This is corroborated by the evidence on the incidence of amalgamations involving private limited as opposed to public limited companies during the period to That evidence shows that, while the overall involvement of private limited firms in the amalgamation process was relatively lower than that of public limited firms during this period, the share of cases involving the former increased from 20 percent during 1985 to 1990 to 31 percent during 1990 to The evidence also shows, as expected,

17 17 that the share of private limited firms involved in the merger process was higher in the non-manufacturing than in the manufacturing sector. Finally, the data shows that in mergers involving nonmanufacturing firms, while the participation of financial companies was less than that of service companies during to , the share of financial companies increased from 26 percent during to 30 percent during to (Beena,1998). Section III The evidence presented in the previous section suggests that the Indian private corporate sector have been considered mergers as a means of growth since the seventies. The present section would focus more on the significance of mergers during 1990s and its characteristics. Before getting in to the discussion, we would like to brief the data, methodology and the sample. Data, Methodology and the Sample An attempt was made to construct a partial list of mergers which had occurred in the manufacturing sector at the all-india level over the period to by visiting the offices of the Regional Directors of the Department of Company Affairs at Kanpur, Madras and Bombay. The office of the fourth Regional Director at Calcutta could not be accessed for various reasons. Though the partial list compiled from the office of the Regional Directors overlapped with the annual list of mergers and amalgamations prepared by the R& D division of the Department of Company Affairs (DCA), it included some firms that were not listed by the DCA. The final list prepared for this analysis consisted of the set of all mergers listed by the R&D division of the Department of Company Affairs and those that were not included in the DCA list but

18 18 whose records were available at the Regional Directors' Offices in three regions. This list is, however, still partial, since it does not cover all firms for which the records are available at the office of the Regional Director of the Eastern region located at Calcutta. It is likely that while a large number of such cases would be covered by the list used here, there would be some mergers that may have been excluded, since they may have been left out of the DCA list. That the likelihood that some of the mergers relating to the Eastern region may have been left out of the DCA list is high is suggested by the fact that a number of cases for which records were available at the offices of the Regional Directors of the DCA at Kanpur, Madras and Bombay were excluded from the All- India DCA list. As a result even the partial list constructed for this study is longer than the all-india list prepared by the R&D division of the Department of Company Affairs. As per the partial list constructed for this study, there were at least 128 public limited firms involved, as acquiring firms, in the merger process in the manufacturing sector during the period to , whereas the lists published by Department of Company Affairs reported only 102 cases. Both these sets are constituted of cases which are governed by sections of the Companies Act, The reason for the divergence between the two sets is not hard to find. There are two reporting steps involved in the preparation of the list published by the DCA. In the first step, as per the law, companies which are involved in a merger are required to inform the Registrar of Companies (ROC) within thirty days of the issue of an order by the High Court sanctioning a merger. In the second step, based on the information received from the companies, the ROC prepares a list of mergers for every month and sends it to the R&D division of the DCA. The all-india list available with the DCA might be incomplete if there is a delay in or a violation of any one of these procedures.

19 19 Significance of the Merger Process During the 1990s A preliminary examination of the acquiring firms involved in the merger process during the 1990s indicates that eventhough they account for a marginal segment of the corporate sector as a whole, the size of that segment has been increasing quite sharply through the 1990s. In order to assess the relative size of the segment involved in the merger process during the 1990s, we chose a sub-sample 109 mergers, in whose case data on the paid-up capital of the acquiring firm was available in the "Directory of Joint Stock Companies" (published in 1990). These firms accounted for around 85 per cent of total number of mergers (128) included in the partial list for the manufacturing sector constructed from the list of the DCA and the files in the various offices of the Department of Company Affairs. A comparison of the total paid-up capital of the acquiring firms involved in the mergers included in our sub-sample with the paid-up capital of the corporate manufacturing sector as reported in the "Annual Report on the Working and Administration of the Companies Act 1956" of the Ministry of Law, Justice & Company Affairs provides a reasonable estimation of the strength of the merger movement during the 1990s. In case the paid-up capital for all the years could not be obtained for any company the paid-up capital in the year 1990 was taken as a proxy. As can be seen from Table 3, the share of paid-up capital of firms involved in the merger process in paid up capital of corporate sector as a whole rose from 1.03 percentage in to 1.42% during , 2.71% in , and 3.54% in An interesting point that emerges from Table 3 is that the strength of the major movement, as defined by us, has not depended on the number of mergers in a particular year. Thus, the relative share of total corporate paid-up capital of the acquiring firms was not high during the year (1.15%) when compared with the other years, in spite

20 20 of it being a year characterised by the occurrence of a large number of mergers. This divergence is because of the participation of a large number of small sized firms in the merger movement in that particular year, making mergers a less important influence on corporate structure as compared with other years. Table 3: Share of Acquiring Manufacturing Firms in the Public Limited Private Corporate Manufacturing Sector During to Rs Lakhs Private Corporate Total Acquiring Firms Share of Acquiring Manufacturing Firms Firms to the Total (%) Year PUC No PUC No PUC No Total Source :- (a) For columns 1 and 2 "Annual Report on the Working and Administration of the Companies Act 1956", Ministry of Law Justice and Company Affairs, GOI, Various Years. (b) For columns 3 and 4 CIMM database, Annual Reports of the various firms, and the Directory of the Joint Stock Companies, 1990, Various Volumes.

21 21 In order to analyse the composition of acquiring firms in terms of total assets, 94 out of 128 acquiring firms have been selected for which the data on total assets could be obtained. Table 4 categorises the total assets figure of all selected acquiring firms for each year during period to into different size classes. While undertaking this exercise we used total assets figure for the year 1990 as a proxy for assets in all years in the case of those firms for which data for the later period could not be obtained. Thus our figures underestimate the significance of merger movement both because the sample is partial and in some cases the data underestimates the actual size of assets. Thus around 41 per cent (39 out of 94) of the acquiring firms belong to the asset-size class of Rs 100 crore and above, which was the cut-off asset figure in the now diluted MRTP Act. Looking at the official categorisation of firms in the sample, it was found that 30 out of the 94 acquiring firms were listed as the MRTP companies as on 30/6/1989 (Company News & Notes,1989). Interestingly, as of , only 13 out of these 30 held total assets which were in excess of Rs.100 cr, whereas the rest of the firms belonged to size classes of below Rs.100 cr as on that date. However, 27 out of these 30 MRTP firms were in size class of Rs.100 cr and above when they went in for the merger. Interestingly, most of these firms which would have at an earlier date been classified as MRTP firms had acquired another firm which both belonged to the same management and produced a similar product. As per the law relating to mergers, any merger involving these characteristics is exempt from obtaining a special clearance from the government under the MRTP Act and could opt for merger through High Court sanction alone. Thus, it may not be true that MRTP regulations were responsible for these mergers not having occurred prior to the 1990s. At the same time, it can further be argued that most of these MRTP firm which have been involved in the merger process could not have opted for this route expansion if

22 22 government had not diluted the MRTP Act. Thus the removal of institutional entry barriers had encouraged a few Indian and foreign firms to redefine their product portfolios and reformulate their corporate and business strategies through the merger process. Among the MRTP firms, big firms dominated the merger process. Thus, 16 out of 39 acquiring firms with assets more than Rs.100 crores belonged to the asset-size class of Rs 500 crores. These 16 firms had accounted for an overwhelming share of per cent of the total assets of the sample acquiring firms. Though 34 percent of the sampled mergers involved small-sized firms belonging to the asset-size category of Rs 1 crore to Rs 25 crores, they accounted for a meagre 0.33 percent of the total assets. Table 4: Size-wise Distribution of 94 Acquiring Firms in Terms of Total Assets and Number (Rs Lakhs) Size Total %Share to total Above 500 crores crores crores crores to 25 crores to 10 crores to 5 crores < 1 crore Total Source: Same as Table 3

23 23 Mergers, Concentration and Profitability The fact that in terms of total assets mergers are concentrated in MRTP firms, points to an increase in concentration as a result of the merger movement. This tendency towards increased concentration was however not too damaging because the merger movement affected a relatively small section of the private corporate sector. To illustrate this we compare the size and performance of 68 out of 107 acquiring firms, in whose case the required data on financial indicators could be obtained, with the private corporate sector as a whole. The size and performance of the latter is taken as being well represented by Reserve Bank of India's surveys of Finances of Public Limited Companies, 1991 to 1992, which give the performance of non-financial public limited firms in the private corporate sector in India. Table 5 presents a comparison of the size of the sample of acquiring firms considered for our purpose and the RBI's sample. The former represents 3.7 percent of the latter in terms of number of manufacturing firms, and accounts for percent of the total paid-up capital of the latter. Further, small firms with paid-up capital smaller than 1 crore accounted for a much larger share of the RBI sample both in terms of number and size of paid-up capital than was the case with the sample of firms involved in mergers. While the latter sample likely to be more biased in terms of inadequate coverage, this evidence of a preponderance of larger firms in the merger movement does tally with some of the results discussed earlier. In terms of financial performance as well, the acquiring firms were among the more successful during to (see Table 6). We have measured profitability by using three different ratios and from this it is observed that the acquiring firms performed relatively better as compared to the overall-manufacturing sector. Firms relying on mergers

24 24 Table 5: Size wise Distribution of Share of Sample Acquiring Firms to the Total Manufacturing Sector(Rs.Lakhs) Size RBI Sample Acquiring Firms % Share PUC No PUC No PUC No >25 crores 301, , to 25 crores 154, , to 10 crores 112, , to 5 crores 156, , Lakhs to 1 crore 30, Lakhs to 25 Lakhs 3, < 5 Lakhs Total 757,900 1, , Maf. = Manufacturing Source:- a) RBI Bulletin, October- November, 1995 b) The table titled "Selected Financial Parameters for the Year in respect of Large-Sized Non-Government Companies each having PUC of Rs. 50 Lakhs or more" in Registration and Liquidation of Joint Stock Companies in India, for growth require less of both their own reserves and debt to finance their expansion. Thus the contribution of reserves and surpluses for generating net fixed assets in the case of the acquiring firms was relatively low when compared with the private corporate manufacturing sector. Similarly, acquiring firms were characterised by a relatively low ratio of debt to equity as compared with the overall-manufacturing sector, suggesting

25 25 Table 6: Financial Performance of Acquiring Manufacturing Firms and the Private Corporate Manufacturing Sector in India Ratios Average PBT/TA Acquiring Na Maf Sector PBT/TI Acquiring Na Maf Sector PBT/NW Acquiring Na Maf Sector R&S/NFA Acquiring Na Maf Sector Debt/Equity Acquiring Na Maf Sector No of firms Acquiring Na 61 Maf. 1,836 1,836 1,720 1,720 1,720 Sector Note: Na: Not Available Source: Same as Table 5 that mergers helped them to maintain a more viable capital structure when compared to the overall-manufacturing sector. Section IV The previous section argued that the new economic environment in the 1990s had facilitated the merger process in the Indian corporate sector. A few large corporations dominated the merger movement during the 1990s. The financial performance of the acquiring firms was relatively better than the performance of the overall private corporate manufacturing sector. The present section seeks to extend that analysis, by looking

26 26 closely at the nature of these mergers in terms of management and of their economic rationale in a selected sample of 45 cases. This reduction in sample size has the added advantage of restricting the analysis to those cases wherein the papers submitted by the firm regarding the scheme of amalgamation provided adequate details and could be accessed. With this objective in mind we chose a sub-sample of 45 mergers out of 94. The choice was determined by the following considerations: i) availability of the scheme of amalgamation; ii) availability of adequate information in the scheme relating to the period of analysis; and iii) listing of the firm in the stock market, which made it easier to obtain any supporting information that may be required. Though the chosen sub-sample covered less than half (47.87 percent) of the mergers, they accounted for almost 99% of the total assets of the acquiring firms covered. This was because special care was taken to cover the major and important merger cases in each year during the period to As a result, most firms have been drawn from the large sized class since the evidence indicates that such mergers dominated during the 1990s. Nature of Mergers Besides the dominance of large sized firms in the merger movement during the liberalisation years in the 1990s, the other remarkable characteristic of the movement was the dominance of mergers between firms under related management. By related management we mean here firms which, either in terms of controlling block or in terms of other indicators like company name, composition of the board of directors, etc. are clearly identifiable as belonging to a particular business group or house. Such information has been extracted from the scheme of amalgamation and other documents related to the firms involved in the

27 27 merger process. As Table 7 shows, more than 70 per cent of the 45 sample cases relating to the period to involved mergers between companies under the same management. In terms of total assets these firms accounted for a comparable percent of the total assets of all the sample firms. The dominance of mergers between related firms is overwhelming even though there are signs of an increase in the role of mergers between unrelated companies or those under different management. In terms of number of firms, the share of 'unrelated mergers' rose almost continuously from around 17 per cent in 1990/91 to 40 per cent in 1994/95. However, in terms of total assets only 6.87 per cent of the total assets of the selected acquiring firms involved in mergers in were of those participating in unrelated mergers. Though this share increased over the 1990s, it remained as low as per cent even in In fact, there was one year ( ) in which the share in total sample assets of acquiring firms involved in unrelated mergers was relatively high (48.4 per cent). However, when looked at in terms of the number of firms involved in unrelated mergers, the figure remained small (3 firms accounting for 27 per cent of the sample firms). The Role of Foreign Firms A second issue of importance in the analysis of merger trends during the liberalisation years is the role of foreign firms in the process. There are a number of reasons why this issue is of importance. To start with, the 1990s were a period in which controls on the operation of foreign firms in India were considerably diluted, encouraging them to set up and build their operations in India. In fact, it has been argued that one of the reasons for the increase in mergers during the 1990s was the keenness of international firms to exploit this opportunity, (Khanna, 1993) which in some instances is furthered through mergers with existing

28 28 Table 7: Pattern of Mergers in India During the Period to Year Unrelated Related Total T Assets % share to T Assets % share to T Assets % share to Total Total Total Total 1,006, ,481, Source: Same as Table 4 and the Schemes of Amalgamation. Table 8: Pattern of Total Mergers in Terms of Ownership (Rs Lakhs) Indian Owned Foreign Owned Total Year T.Assets % share T.Assets % share to T.Assets % share to to the total the Total the Total Total Source: Same as Table 4.

29 29 operators rather than through the establishment of greenfield projects. Secondly, the 1990s have been years in which foreign direct investment flows into India have risen from less than half a billion dollars to more than 3 billion dollars a year. This makes India's experience a part of the international experience with regard to rising FDI flows during the 1990s. Interestingly, one aspect of the latter has been the role of rising crossborder mergers and acquisitions in explaining the cross-border flows of capital. It would therefore be useful to examine whether foreign firms in part due to an increase in cross-border mergers resort to the rise in FDI flows into India. Finally, the liberalisation years have seen some striking instances of acquisitions and mergers involving foreign firms. However, the evidence yielded by our sample partially confirms these expectations. Foreign firms have a significant presence among acquiring firms involved in the merger process, but not a dominant presence. In the 45 sample cases studied, foreign owned business firms controlled percent of the acquiring companies. In terms of total assets of the sample-acquiring firms, their share was even lower at percent. The rest of the mergers were between the companies under Indian ownership. But it needs to be noted that the presence of foreign firms among merging entities is visible only after (See Table 8). This could be because the relaxation of FERA regulations occurred in January 1992, when foreign companies were allowed to open branches, permitted to use their trademarks, carry out any activity of a trading, commercial or industrial nature, borrow money and accept fixed deposits like any other Indian company. It is noteworthy that in 1992/93, foreign firms, which were not involved in mergers till that year, accounted for onethird of the acquiring firms in the sample, and for almost half the total assets of the sample acquiring firms. Though these shares fell in the subsequent two years, they did remain significant.

30 30 What is interesting is the nature of mergers analysed in terms of relationship between the management of merging firms. As is to be expected from our analysis earlier, out of the mergers involving Indian owned acquiring firm, around 71 per cent was between companies under related management. However, looked at as a trend, there appears to be a marginal shift towards the participation of unrelated entities in mergers involving Indian owned firms, with a sharp swing in favour of unrelated mergers in 1994/95. While these aspects of mergers between Indian owned firms is as expected, the structure of mergers involving foreign firms is surprising. Here also we find that mergers between firms under the same management play an important role, accounting for 70 per cent of the mergers and almost 80 per cent of total assets of acquiring firms involved in 'foreign-owned mergers' during the 1990s. Thus, the factors that encouraged splitting of operations in India in the years prior to liberalisation obviously influenced foreign players as well, and the need to retreat from that strategy in the liberalisation years seems to also apply in their case. Finally, if we compare the relative roles of Indian- and foreignowned firms in mergers involving the same and those involving different managements. We further observed that while the dominance of Indian owned firms in the arena of related mergers was complete, their dominance over the arena of unrelated mergers was also overwhelming. The similarity in distribution across related and unrelated mergers implied by these figures suggests that the pattern and therefore the objectives of foreign firms involved in mergers were more or less the same as those of Indian firms. Structure of Mergers Some idea of the nature of such internal restructuring can be gleaned from an analysis of the structure of mergers during the 1990s. Based on the product profile of the acquiring and acquired firms, the

31 31 selected mergers have been categorised into horizontal, vertical and conglomerate mergers. This exercise has been carried out based on the data available in the Directory of the Bombay Stock Exchange. Out of the 45 sample cases chosen for this study, around 69 per cent (31 cases) were horizontal mergers (i.e. between the firms under the same industry). The remaining cases were divided equally between vertical mergers (between the firms which are complementary to each other) and conglomerate mergers (between firms producing unrelated products). In terms of total assets, however, only per cent of the total assets were with acquiring firms involved in horizontal mergers, whereas a disproportionately large per cent were with firms involved in vertical mergers (See Table 9). Conglomerate mergers accounted for a relatively small 5.11 percent of the total assets of the acquiring firms. These figures suggest that while horizontal mergers dominate, some of the larger firms were opting for vertical mergers, leading to a higher share of assets involved in such mergers as compared with their share in the number of mergers. Conglomerate mergers between firms in different industries were both asset-wise and numerically not a significant option. Further, the evidence points to an increasing trend in the share of horizontal mergers both in terms of number and total assets during the period of analysis, whereas conglomerate mergers registered a declining trend over time. Thus the internal restructuring that resulted in the spate of mergers during the 1990s appears to be of two kinds. Firstly, there are signs of consolidation aimed possibly at increasing size, deriving marketing advantages, deriving financial benefits for specific or all shareholders and exploiting scale economies outside that of production (since the units already exist as separate entities). Secondly, there are signs of mergers aimed at the synergies associated with vertical mergers; at linking more closely the production plans of related firms; at reducing costs through transferring margins to the final stage; at increasing size; and at deriving financial benefits for specific or all shareholders.

32 32 The dominance of horizontal merger has, as expected, affected the product market share of individual acquiring firms before and after merger. We estimated the share of value of sales by product lines of a sample of 43 acquiring firms in their corresponding 'industry totals' for the period and The market share of the major product lines of these acquiring firms and the total sales of the corresponding industries are collected from the India's industrial sector, 1996 published by Centre for Monitoring Indian Economy Pvt.Ltd. It needs to be noted that the "industry total" provided there, in some cases, included the sales of only a selected set of major firms within that industry. However, from this exercise, it is observed that the ratio of the total sales of the sample of acquiring firms to the total sales of the respective industries has increased from 0.24 to 0.58 during the period to The ratio of the total sales of those acquiring firms which have merged with the related product lines to the total sales of the respective industries has increased from to Thus, even if not substantially due to related mergers, the process of amalgamation does seem to have contributed to some increase in product-wise concentration. However, as mentioned earlier since related mergers dominated the merger movement, these changes would not have amounted to much when we take account of the fact that the representative unit of capital 2 in the India's corporate sector is the business group and not the individual firm. 2 The defining feature of this unit was that unlike the diversified, single conglomerate firm which was the industrial, decision making unit in the West, the business group consisted of a large number of legally independent firms which functioned as a single entity according to the dictates of a single decision-making authority (see Dutt, 1969; Ghose, 1972; Hazari, 1986).